Oct. 15 (Bloomberg) -- In any Japanese dictionary, next to the word ``zombie,'' there should be a mention of Daiei Inc. News that creditors have forced a government bailout of Japan's most-indebted retailer should unnerve investors in the world's No. 2 economy.

Daiei is the quintessential undead company. During the bubble years of the 1980s, it expanded into just about anything it could. Convenience stores, hotels, restaurants, credit cards, baseball, Hawaiian shopping malls, you name it. As of Feb. 29, the Daiei group had 114 companies.

When the good times ended, Daiei was weighed down by its subsidiaries. Its undisciplined growth drained profitable businesses, necessitating ever-increasing numbers of financial lifelines from banks. Daiei may be the ideal case study in how Japan's 1980s excesses planted the seeds of its slide in the 1990s.

So it's with much eye-rolling and trepidation that investors digest news Daiei is yet again arising from the grave. Even though promising private-sector solutions came its way from the likes of Wal-Mart Stores Inc., Ripplewood Holdings LLC and Goldman Sachs Group Inc., Daiei is instead getting a third bailout in as many years. This week, it applied for aid from the state-run Industrial Revitalization Corp. of Japan.

A Private Solution?

Previously, Daiei refused to seek help from the agency for dealing with about 1 trillion yen ($9.1 billion) of debt, favoring a private solution that would leave it with more control over the outcome. Daiei's main creditor, UFJ Holdings Inc., insisted on government involvement as it attempts to trim its lending to the retailer before merging with Mitsubishi Tokyo Financial Group Inc.

The upshot is Japanese taxpayers will foot the bill. The episode also reminds investors that talk of corporate reform in Japan is as much about hype as reality. That Daiei is still around -- living handout to handout -- shows Japan's corporate restructuring remains in first gear.

The role of politics can't be ignored here. For one thing, the ruling Liberal Democratic Party is loath to see Daiei's nearly 40,000 employees lose their jobs. For another, the IRCJ needs to justify its existence. Created with high hopes last year, it's still searching for that headline-grabbing turnaround story.

Yet those who think Daiei is too big to fail don't seem to realize Japan's third-largest retailer may be too big -- or too indebted -- to save. Moreover, it's difficult to avoid the conclusion that Japan still has little interest in the creative destruction needed to breathe life into its economy.

Health Impediments

Japan's ongoing recovery is the best chance it's had in a decade and a half to return to economic health. While it owes much to strong global growth, corporate restructuring also has played a vital role. If it's going to continue, companies must step up efforts to cut costs, reduce debt, sell off non-core businesses and, where needed, shift production abroad.

It's equally important that the government deregulate what still is one of the developed world's most rigid economies. So is tackling the dual structure of the economy.

On the one hand, Japan boasts highly efficient, globally competitive industries and companies like Toyota Motor Corp. and Canon Inc. On the other, it's home to all-too-many bloated, uncompetitive ones -- like Daiei -- that wouldn't survive in most economies. Closing the gap is key to future prosperity.

Debt is at the heart of it all. Not only do companies need to use the 5 percent growth the International Monetary Fund predicts for this year to reduce debt, but so does the government. Japan's debt-to-gross-domestic-product ratio is approaching 150 percent -- the highest among developed nations. Yields here may only rise if the government doesn't curtail bond sales, making life harder for highly indebted companies.

Kanebo Redux

Also central to the Daiei episode is the government getting in the way of a market-based solution. It harkens back to the saga last February at Kanebo Ltd., in which Japan's second-biggest cosmetics maker was about to sell itself to Kao Corp.

The idea was to create a cosmetics business with nearly 300 billion yen in annual sales, expand in China, and actually turn a profit. Instead, Kanebo -- like all too many companies before it -- opted for a state-backed rescue. The bailout offered by the IRCJ effectively short-circuited the market while putting taxpayers' money at risk. We're seeing a similar turn of events with Daiei.

To be sure, Daiei's rehabilitation is a work in progress and may include help from the private sector. Yet with the IRCJ running the show, one wonders if Daiei's assets will be sold for as much as a savvy investment bank might demand. And the IRCJ may tread more carefully on job cuts, even when they are absolutely necessary.

Chief Cabinet Secretary Hiroyuki Hosoda yesterday said Daiei's decision to seek state aid will bolster the nation's financial sector. Yet Japan-recovery skeptics sometimes joke that until zombies like Daiei are allowed to die, many investors will look askance on Japan's determination to reform its economy.

Anyone who thinks Japan's current economic recovery is different from previous ones that fizzled should monitor how the Daiei saga plays out.

To contact the writer of this column: William Pesek Jr. in Tokyo wpesek@bloomberg.net

Last Updated: October 14, 2004 21:32 EDT